Dollar extends recovery on post-election relief

LONDON (Reuters) – The dollar rose on Thursday, pulling further away from 2-1/2 week lows hit on Wednesday, as the market breathed a sigh of relief after the U.S. midterm elections and as investors turned their attention towards the Federal Reserve policy meeting.

The Federal Reserve is expected to keep interest rates on hold but signal further tightening in December.

Analysts said that with the U.S. midterm elections producing no major surprises a central bank sticking to its tightening path should support the dollar, while the euro will likely remain under pressure from concerns about Italian debt.

“The election results were in line with expectations and mean the Fed can go on its way,” said Alvin Tan, FX strategist at Societe Generale, adding that a December rate hike was only 80 percent priced in by the market.

The mid-term elections resulted in a split Congress, with Democrats winning control of the House of Representatives and Republicans cementing their majority in the Senate, and the results were largely cheered by a rallying Wall Street.

The euro was largely unmoved ahead of a report from the European Commission that is expected to highlight the country’s 2019 deficit may be much higher than suggested by Italy. Rome remains locked in a dispute with European officials over its budget spending plans.

The euro rose 0.1 percent to $1.4440 <EUR=>.

“Perhaps the EU will be unable to make the Italian government realise the errors of its ways, as a deficit procedure takes a long time and has an uncertain outcome, so that the prospect of it is unlikely to put pressure on the government. But perhaps the market will be able to achieve more,” Commerzbank analysts said, referring to the rise in Italian government bond yields.

Other major currencies largely traded in narrow ranges, with British pound off recent highs after a strong rally on the back of optimism for a Brexit deal between Britain and the European Union. The dollar strengthened 0.2 versus the yen to trade at 113.70 <JPY=>. The dollar has gained over the past week versus the yen due to the diverging monetary policies of the U.S. Fed and the Bank of Japan. While the Fed is on track to raise interest rates the Bank of Japan will press on with ultra loose monetary policy because of low growth and inflation.

The widening interest rate differential between U.S. and Japanese bonds has made the dollar a more attractive bet than the yen, which is often a funding currency for carry trades.

The New Zealand dollar <NZD=> traded roughly flat at $0.6788, with little reaction to its central bank keeping rates on hold at 1.75 percent on Thursday. The Australian dollar <AUD=> built on its gains of the previous three trading sessions versus the greenback to trade at $0.7295, up 0.3 percent.

The Aussie was cheered by stronger than expected trade data out of China, its largest trade partner.